ECON 1001 - PowerPoint PPT Presentation

ECON 1001. Tutorial 10. Q1) A dominant strategy occurs when One player has a strategy that yields the highest payoff independent of the other player’s choice. Both players have a strategy that yields the highest payoff independent of the other’s choice. Both players make the same choice.

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The N.E. is also known as pure strategy N.E., the adjective “pure strategy” is to distinguish it from the alternative of “mixed strategy” N.E. A mixed strategy N.E. is a N.E. in which players will randomly choose between two or more strategies with some probability.

As Matthew is a rational individual, he will choose a lower branch (i.e., arriving the node Z).

(1000, 1000)

Dean

Y

(500, 1500)

X

Matthew

*

(1.5m, 1m)

Z

Dean

(400, 1.5m)

Q10) Suppose Dean promises Matthew that he will always select the upper branch of either Y or Z. Dean offers to sign a legally binding contract that penalises him if he fails to choose the upper branch of Y or Z. For the contract to make Dean’s promise credible, the value of the penalty must be

As Matthew picks the lower branch (i.e., arriving at node Z), there is a tendency for Dean to the lower branch (i.e., arriving the payoff of (400 for Matthew and 1.5m for Dean) -- for a higher payoff (compared with 1m for Dean).

The penalty of breaching the promise should then be at least $0.5m (say $0.6m). The penalty will reduce the payoff to Dean (becomes 1.5-0.6 = 0.9) when Dean chooses the lower branch at node Z. Thus, Dean will choose the upper branch at node Z.